Misallocation and Capital Market Integration: Evidence from India

70 Pages Posted: 19 Oct 2020 Last revised: 20 Nov 2021

See all articles by Natalie Bau

Natalie Bau

University of California, Los Angeles (UCLA)

Adrien Matray

Princeton University

Multiple version iconThere are 2 versions of this paper

Date Written: October 2020


We show that foreign capital liberalization reduces capital misallocation and increases aggregate productivity in India. The staggered liberalization of access to foreign capital across disaggregated industries allows us to identify changes in firms' input wedges, overcoming major challenges in the measurement of the effects of changing misallocation. For domestic firms with initially high marginal revenue products of capital (MRPK), liberalization increases revenues by 25%, physical capital by 57%, wage bills by 27%, and reduces MRPK by 35% relative to low MRPK firms. There are no effects on low MRPK firms. The effects of liberalization are largest in areas with less developed local banking sectors, indicating that foreign capital partially substitutes for an efficient banking sector. Finally, we develop a novel method to use natural experiments to bound the effect of changes in misallocation on treated industries' aggregate productivity. Treated industries' Solow residual increases by 4-17%.

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Suggested Citation

Bau, Natalie and Matray, Adrien, Misallocation and Capital Market Integration: Evidence from India (October 2020). NBER Working Paper No. w27955, Available at SSRN: https://ssrn.com/abstract=3714447

Natalie Bau (Contact Author)

University of California, Los Angeles (UCLA) ( email )

405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095
United States

Adrien Matray

Princeton University ( email )

Bendheim Center for Finance
26 Prospect Avenue
Princeton, NJ 08540
United States

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